Tuesday, December 15, 2015

Institutions and experience

These are remarks I prepared for a symposium at Hoover in honor of George Shultz on his 95th birthday. Willie Brown was the star of the symposium, I think, preceded by a provocative and thoughtful speech by Bill Bradley.Institutions and Experience

Our theme is “learning from experience.” I want to reflect on how we as a society learn from experience, with special focus on economic affairs. Most of these thoughts reflect things I learned from George, directly or indirectly, but in the interest of time I won’t bore you with the stories.

An English baron in 1342 tramples his farmers’ lands while hunting. The farmers starve. Then, insecure in their land, they don’t keep it up, they move away, and soon both baron and farmers are poor.

How does our society remember thousands of years of lessons like these? When, say, the EPA decides the puddle in your backyard is a wetland, or — I choose a tiny example just to emphasize how pervasive the issues are — when the City of Palo Alto wants to grab a trailer park, how does our society remember the hunter baron’s experience?

The answer: Experience is encoded in our institutions. We live on a thousand years of slow development of the rule of law, rights of individuals, property rights, contracts, limited government, checks and balances. By operating within this great institutional machinery, these “structures” as senator Bradley called them last night, these “guardrails” as Kim Strassel called them in this morning’s Wall Street Journal, our society remembers Baron hunter’s experience in 1342, though each individual has forgotten it.

In particular, self-appointed technocrats — us economists — do not offer “advice” to benevolent “policymakers” to implement, though we often so flatter ourselves. Strong institutions of limited government defend against bad and transitory ideas.

Hayek told us how prices transmit information through an economy, information that no individual knows. In a similar manner, these institutions encode memories and wisdom that no individual remembers.

These great institutions do not operate of their own. They need maintenance, repair, continual improvement, and the incorporation of new experience. I am not arguing for mindless conservatism. Many of our legal structures have been, and continue to be, in need of fundamental changes.

But the mechanics who fix them, their operators, and us, their beneficiaries, need to be vaguely aware of how the machine works and why it is built the way it is. When institutions, structures, long standing traditions, rights, separations of power and so forth are abandoned or broken, when guardrails are smashed, the treasure trove of experience involved in their construction can be lost.

The Era of Forgetting

In this regard, I fear we live in an era of great forgetting.

Foreign policy increasingly seems unhinged from simplest lessons of history as well as from the carefully built institutions of the postwar order. Eisenhower and Roosevelt did not call a press conference, announce the US putting 5000 soldiers on Omaha beach, and promise the soldiers would be out by July. They set a goal, and promised to unleash whatever resources are needed for that goal. As senator Bradley reminded us, they knew that managing the peace is just as important as winning the war.

As John Taylor reminds us in his remarks today, monetary and financial policy has veered away from its traditional base in both domestic and international institutions and institutional limitations.

In economic and domestic affairs, the administration and its regulatory agencies are more and more telling people and businesses what to do, unconstrained by conventional rule-of-law restrictions and protections.

But what will happen on a change of administration? Will a new administration retreat, say we must restore rights and rule of law? Or will a new administration — once again — admire an expanded set of tools for ramming through its agenda, punishing political enemies, demanding cooperation of people and business, and set to work institutionally grabbing power for itself?

The temptation will be strong: To direct Lois Lerner’s successor to blackball different applications; to use campaign laws to persecute a different set of officials; to have its environmental, health care, and financial regulators demand the same tribute and that a different set of doors revolve; to wipe out its predecessors executive orders and issue new ones.

Or will it say, no, we eschew these methods, we will go back to respect and rebuild institutional limits, though it will take a long time and reduce our hold on power? Once the traditional restraints are broken, it’s awfully hard to go back.

The leading candidates have already promised which way they’re going. For example, Ms. Clinton, quoted by Kim Strassel, promises to use Treasury regulation to punish companies that legally reduce taxes by moving abroad. And Mr. Trump outrages the law and constitution daily.

Every society needs institutions to pass on its structures and traditions to the next generation. Grade for yourselves how well our schools and universities, even Stanford, are doing to pass on the lessons of limited government, rule of law, individual rights; the institutional wisdom of western democracy.

Our society’s premier institution for collecting, vetting, and passing on experience, science itself, is in trouble. The politicization of climate research is only the latest example.

Our policy debates are taking on a magical tone. Simple lessons of hundreds of years of experience, simple logic of cause and effect, and basic quantification, are disappearing.

Long experience tells us simple steps that encourage economic activity: Low, stable and simple taxes, good public infrastructure, an efficient legal system, predictable simple and uncorrupt regulations, and largely stay out of the way.

Long experience also teaches us many mistakes. For example, price and quantity controls induce scarcity, illegality, sclerosis and poverty. It also teaches that grand plan after grand plan for government directed growth or development has fallen apart.

But our policy debates chase ghosts instead. Rather than fix these humble and broken institutions, we are consumed whether Ms. Yellen might pay banks a quarter of a percentage more on their reserves. Action is regularly demanded over “bubbles,” “imbalances,” “reach for yield” “risk premiums” and so forth, as if anyone had any idea what these meant let alone scientific understanding of what one should do about them.

Serious people and international institutions advocate that the road to prosperity is for the government to borrow money and deliberately waste it; to confiscate wealth by extortionate taxation; to welcome natural disasters for their stimulative rebuilding opportunities; to deliberately throw sand in the gears of productivity; almost magic recommendations that ignore centuries of experience.

(To clarify: yes, we should keep our minds open new ideas. Quantum mechanics sounded like magic when introduced. I play with radical ideas too, such as the idea that higher interest rates lead to more, rather than less, inflation. The issue is, how quickly should new, revolutionary, everything you thought you knew is wrong ideas make their way to public policy? Too much economic policy jumps from "here's a cool idea I thought up on the plane" to "the US should spend a trillion bucks." I do not advocate that the Fed should act on my latest paper!)

Our regulatory policy seems a parody of making the same mistakes over and over and refusing to learn the lessons. The Dodd-Frank act is not a new idea. It simply tries again and bigger the same set of ideas that failed in crisis after crisis — guarantee debts, bail out banks, and add more regulators in the vain hope to stop increasingly large, politicized, too big to fail and hugely over leveraged banks from ever losing money again. The ACA/Obamacare is not a new idea. It just adds layer after layer of the same health insurance and care regulations that failed before. This time price controls will surely work to lower costs without cutting supply or innovation — let’s forget the thousands of times they have failed.

And economics is relatively sensible. Magical beliefs pervade our political system’s discussion about terrorism, migration, or the environment. No, a high speed train will not fill California’s reservoirs, or stop terrorism or refugee migration.

There is a late Roman empire feeling in the air. Conventional limitations on action are ignored. People distrust the great institutions of their society, have neglected them, and now they have forgotten how those institutions work. People follow inspirational leaders, who use any tools at their disposal to crush enemies — only to be crushed in turn. New magical faiths sweep through. I fear that our grandchildren will walk among wondrous ruins like medieval villagers, having forgotten how to make concrete.

Optimism

But I learned an important lesson from George Shultz: Any time I start down this sort of line of thought, he says, "Stop being so grumpy!" As Ronald Reagan famously put it, there must be a pony in here somewhere. There is.

Our society also has self-correcting institutions. You’re sitting in one, and you’re part of that process today. We’re here. The ideas that define a free — and prosperous — society are alive. The memory of a rule of law structure is alive.

We still have a free press, for now relatively free speech and most people still understand how important that is. The full potential of the regulatory and surveillance state to silence dissent has not yet been used. And in that press, and Internet, horror stories are adding up. People are getting sick of it.

Congress has noticed. There are good people who want to pass simple clear laws and bring back its rule.

For example, In November the House Judiciary Committee passed (WSJ commentary) a package of regulatory reforms. One is, to be guilty of a crime, you must have some intent to violate the law. They can’t charge you after the fact with unknowable laws or regulations, evidence such as statistical discrimination programs that you cannot see or challenge, and fine you millions or put you in jail without even claiming you intended any harm.

This principle of intent, “mens rea”, is a centuries-old bedrock of common law. It encodes a thousand years of experience. It is sad that Federal regulations forgot and trampled it. But it is great news that an effort to fix it is under way. A wider set of rights against regulators, a magna carta for the regulatory state, reestablishing the rights to know the rules ahead of time, to see and challenge evidence, to appeal, and to speedy judgment could well follow.

Financial regulators are seeing daily how ineffective the Dodd-Frank apparatus is. Slowly but surely, the realization that very simple capital standards can obviate this mess is making way. You heard it from Senator Bradley last night.

I see hope on climate. There is a small but increasing alliance between environmentalists and free-marketers. The environmentalists think carbon is such a big problem, that they want policies that will actually do something about it. Free marketers are aghast at the waste and cronyism of energy policy. They are coming together on a deal: A simple straightforward carbon tax in place of wasting money and economic capacity on tax dodges, crony subsidies and ineffective regulations. Sure, there will be a big discussion on the rate, but any conceivable rate will be a big improvement for both environment and economy.

Similar grand bargains on taxes and entitlements are sitting before us, needing only a small amount of leadership and public pressure. The experience of 1982 and 1986 is not forgotten.

A hunger for monetary policy anchored in rules or at least strong institutional traditions and constraints is palpable, even producing bills in Congress. Those may not be perfectly crafted, and may not pass. But the force for rebuilding an institutional structure for monetary policy is there.

Collegiate humanities and social science education has passed the point of the fashionable to the ridiculous, so that study of the successes of western civilization, and not just its many sins, is returning.

I don’t yet hear “it’s your property, do what you want with it” from the Palo Alto zoning board, or the citizens who elect them, but who knows, that too is possible someday.

Even the widely reported disgust with government has a silver lining. People who distrust the government are less likely to vote for the next big personality promising big new programs. Instead, they might be more attracted to candidates who promise restraint and rule of law; to administer competently and to repair broken institutions.

Our society codes its experience into its institutions; in a grand edifice we call limited government and rule of law. The old boat is rusty, but she’s not beyond hope. The bilge pumps are working. And we face no real external pressures. ISIS is the JV; compared to the Visigoths, or to Germany, Japan and the Soviet Union. A rich China should be a godsend, posing no more threat than a rich Europe and Canada. Silicon valley is full of ideas and entrepreneurs waiting to unleash prosperity on the country. If only they can get the permits. If we fail, and the grand forgetting takes over instead, the fault will only be our own.

19 comments:

I believe the reference should be to the late Roman Republic, as the empire faded away due to its despotic nature. The Republic yielded to the despotic empire, in large part due to its poor financial position resulting from military adventurism, money debauchery and blanket loan forgiveness by writ. I recommend "History of the Roman Republic" by Theodore Mommsen. (A book that the Founders likely read, as well, because they wanted to know how things might end. Yes, it's that old a book.)

When was this time when politicians did not use "any tools at their disposal"? During the Nixon Administration? Hoover's FBI? WWII?

Economic theories implying that government has a role to play in managing demand during recessions are not at all new. They are older (and reflect more experience) than your beliefs in fully self-correcting markets.

And how does your call for a repeat of "Omaha beach" reflect the experience of Vietnam?

In general it is funny how any change you politically favor is "maintenance, repair, continual improvement", while changes you oppose are "New magical faiths"

Maybe politicians are more interested in the lessons learned from those who wielded huge amounts of power: Julius Caesar, Genghis Khan, Stalin, Mao - or even the lesser lights such as Papa Doc, Idi Amin, and Slobodan Milosevic. We have our own homegrown luminaries - Boss Tweed, The Great Robber Barons, Huey Long, etc.

If you are a power-hungry sociopath those are your role models.

"People who distrust the government are less likely to vote for the next big personality promising big new programs. Instead, they might be more attracted to candidates who promise restraint and rule of law; to administer competently and to repair broken institutions."

Alternatively, they might decide that they don't trust career politicians and pick Trump or Carson as a solution.

It’s difficult for me to understand why someone would disagree with the core institutional principles that this post talks about (e.g., simplicity and efficiency), but has it really been a collective bad memory or is it possible that there are some inherent institutional flaws that impede self-correction? The main question that I have after reading this post is whether these institutions can be empowered to realize when they need to change themselves? Currently it seems that the way this will be achieved is once enough of us – the beneficiaries of the institutions – realize that something has fundamentally gone awry with our institutions and demand that they be changed (as alluded to in the Dodd-Frank and climate issues above), but this itself seems to have a sense of inefficiency to it.

I agree that us institutional beneficiaries need to be vaguely aware of how the institutions operate and why, but it seems that the more complex the institutions are, the less likely we are to understand why they are the way that they are.

"Foreign policy increasingly seems unhinged from simplest lessons of history as well as from the carefully built institutions of the postwar order. Eisenhower and Roosevelt did not call a press conference, announce the US putting 5000 soldiers on Omaha beach, and promise the soldiers would be out by July."

It did? See:https://en.wikipedia.org/wiki/War_Powers_Resolution

"The War Powers Resolution requires the President to notify Congress within 48 hours of committing armed forces to military action and forbids armed forces from remaining for more than 60 days, with a further 30 day withdrawal period, without a Congressional authorization for use of military force or a declaration of war."

Eisenhower and Roosevelt acted on the behest of the Congress. The War Powers Act was enacted after Nixon ignored Congress when they repealed the Gulf of Tonkin Resolution (1971).

John, a great post and a wonderful speech, although I'm sue you received some strange looks when you discussed climate change. Very honorable thing for you to do this.

Notwithstanding the paucity of comments you received here, you might want to consider submitting this to the Editorial page of the WSJ, if you haven't already done so. I notice you are published there from time-to-time, and I would think readers would eat up your message.

It is a great Hayekian (and Burkean) insight that institutions embody the accumulated wisdom and knowledge of past experience. But this cuts both ways. Established administrative and bureaucratic structures also embody past experience--but they embody corrupt political arrangements designed to secure rents and pass on patronage to relevant elites. Evaluating institutions, even those graced by longevity and rich history, is not so straightforward. This is a great insight of public choice economics after all. Foundational political economic institutions may well be products of perverse incentives that run deep in Western history as cronyist, oligarchic power sharing mechanisms.

This isn't meant to be an objection to Professor Cochrane's remarks of course--the bulk of which are incisive and absolutely right. My point is merely to suggest a danger in overemphasizing the wisdom of accumulated experience as embodied in institutions.

I hope to see the discussion on the carbon tax grow, but I wonder if that day will ever come. I think there are many climate change skeptics that will balk at the carbon tax simply on principle. I consider myself not so much as a climate change skeptic as much as I consider myself a skeptic that the throngs of self-appointed science doyens that have seemingly descended into a colossal mob mentality group think aligned with cynical politicians happy to use the fear-mongering to shower subsidies on their pet projects will have any discernable impact while wasting trillions of dollars along the way. Far better that if we agree that there is some risk of man-made climate change, no matter how far into to "black swan" tail end of the probability curve it is, it would be far better to implement the carbon tax and offset other forms of taxation to make it politically palatable. Then, the market will adjust to the activities in innovative and efficient ways. The cronyist ways in which we allow the government to pick and choose winners and to create arbitrary and unaccountable legislation through the EPA is the current alternative - and this undermines liberty and the rule of law far more than a simple and understandable and navigable carbon tax.

I hope to see the discussion on the carbon tax grow, but I wonder if that day will ever come. I think there are many climate change skeptics that will balk at the carbon tax simply on principle. I consider myself not so much as a climate change skeptic as much as I consider myself a skeptic that the throngs of self-appointed science doyens that have seemingly descended into a colossal mob mentality group think aligned with cynical politicians happy to use the fear-mongering to shower subsidies on their pet projects will have any discernable impact while wasting trillions of dollars along the way. Far better that if we agree that there is some risk of man-made climate change, no matter how far into to "black swan" tail end of the probability curve it is, it would be far better to implement the carbon tax and offset other forms of taxation to make it politically palatable. Then, the market will adjust to the activities in innovative and efficient ways. The cronyist ways in which we allow the government to pick and choose winners and to create arbitrary and unaccountable legislation through the EPA is the current alternative - and this undermines liberty and the rule of law far more than a simple and understandable and navigable carbon tax.

The mens rea requirement is premised upon the idea that one must possess a guilty state of mind and be aware of his or her misconduct; however, a defendant need not know that their conduct is illegal to be guilty of a crime. Rather, the defendant must be conscious of the “facts that make his conduct fit the definition of the offense.”

"If you structure the carbon tax as Hansen suggests - refunding the tax revenues equally on a per-capita basis - you appropriately motivate both the wicked and the righteous."

Except, the federal government is not legally permitted to do that. Suppose the federal government receives $100 in carbon tax revenue and has $50 worth of outstanding debt service payments. It cannot legally refund the $100 in carbon tax revenue equally on a per capita basis because payments on the federal debt supercede all other expenditures.

Also, if tax revenues from a carbon tax are dispersed on a per capita basis, then carbon tax payers are also recipients of that revenue, receiving their per capita share - yes? Granted, if carbon taxes are assessed as a percentage of total emissions, there will be individuals paying more in taxes than they receive back.

It seems that Hansen treats a carbon tax as a redistribution scheme rather than an absolute punishment / reward system. In a world full of wicked carbon emitters - would the tax and expenditure have any effect? In a world full of righteous breath holders - would the tax and expenditure have any effect?

I appreciate some of the things you are doing here, and I like the way you are thinking about things historically. It's not deep history, sure, but I appreciate the effort and the thought. If we are going to think about these things, we need to think outside neo-classical models. I would describe myself as a Keynesian, but I agree with you about the increase in instrusive regulation. It might be worth you picking up some of the Neo-Marxian literature or Adorno/Habermas, just for another point of view - they talk about 'bureaucratic-capitalism'; the mainstream economics profession talks about a zero sum game between government and private sector activity and a strict demarcation between them. Not in this literature. You will also find a lot of explanations for the rise in political apathy, ineffectiveness and detachment between the public and the leadership that arises in advanced capitalism.

It’s the conservative who would interrupt what seems to be an endless modern dialectic between oikophobia and xenophobia—between globalism and fascism—with the mean between those extremes, that being the nation. The nation—and it is not to be confused with the tribe or the church, or even nationalism—is the only place where the protection of human rights can be effective, through law and also through habituation. The nation is where we learn how to treat strangers with the respect we instinctively accord to friends.

From an edifying companion piece to this Cochrane essay:http://www.libertylawsite.org/2015/12/22/the-functional-anthropologist-roger-scruton/

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About Me and This Blog

This is a blog of news, views, and commentary, from a humorous free-market point of view. After one too many rants at the dinner table, my kids called me "the grumpy economist," and hence this blog and its title.
In real life I'm a Senior Fellow of the Hoover Institution at Stanford. I was formerly a professor at the University of Chicago Booth School of Business. I'm also an adjunct scholar of the Cato Institute. I'm not really grumpy by the way!